Private Student Loans: What to Watch Out For

Federal student loans make up the overwhelming majority of outstanding student loan debt, but millions of borrowers also take out private student loans.

Do Banks Provide Student Loans?

Yes. Private education loans, also called alternative loans, are originated by private banks and credit unions, as opposed to federal education loans, which are originated by the Education Department and institutions of higher education.

Turning to a private education loan for help with climbing college costs can be tempting. With an online application and the promise of a low interest rate, a private loan often looks easy and affordable.

How Are Federal Student Loans Different From Private Student Loans?

Federal loans have a fixed interest rate and offer a variety of borrower benefits, like forbearance, deferment, loan consolidation, student loan forgiveness and several repayment plans. And if you default on your student loans, you may be able to undo some of the damage through the federal loan rehabilitation program. (Here’s a brief overview of what student loan default is and what it means for borrowers.)

Private loans generally aren’t as flexible. And unlike federal student loans, private loans often have variable interest rates and require credit checks. So you’ll need a good credit history or a cosigner to land a low rate. If you have less-than-stellar credit, you could end up paying high interest rates. Also, because rates on private loans can fluctuate according to market conditions, whatever interest rate you qualify for could change. (Curious about your credit? You can see where you stand by viewing two of your credit scores on Credit.com.)

The repayment terms on a private education loan vary by lender. With some lenders, repayment begins immediately. Other lenders may allow borrowers to defer loan payments while attending classes, as federal loans do.

You’ll also likely have fewer borrower protections with private loans than you do with federal loans.

Federal loans come with a range of borrower protections mandated in the federal Higher Education Act. For example, with federal Direct, Family Education and Perkins loans, borrowers can postpone payments for up to three years if they suffer economic hardship or unemployment, as long as the borrower meets eligibility requirements for these deferments. Federal loan servicers may also offer forbearance, a temporary postponement of payments, for up to 12 months at a time. Private education loan lenders are not required to offer forbearance or deferment options. Some lenders charge fees to process forbearance and deferment requests and may have shorter deferment or forbearance periods.

A private loan is an option to consider after you’ve exhausted federal lending options (most federal loans, after all, have borrowing limits below the cost of attendance, which private loans do not). When borrowing to pay for your college education, most experts recommend applying for federal loans first and private loans as a last resort. If you’re applying for a federal student loan, make sure you fill out the Free Application for Federal Student Aid (FAFSA). It’s required to get any kind of federal aid, including loans. To land a good deal on a private education loan, you’ll need to shop carefully. Rates and fees vary.

What to Ask a Private Student Loan Company

Here are some important questions to ask when shopping for a private loan:

What are the credit qualifications? All private education loans require a credit check. Private lenders may consider your credit record, assets, debts, income, your college or university and your field of study. If you have limited or flawed credit, as many students do, you may be approved for a loan at a higher interest rate or require a cosigner to qualify for a loan.

What is the interest rate on the loan and how is the rate calculated? Interest rates on private education loans vary, and many private loans come with variable interest rates that fluctuate with market conditions. The interest rate on a private education loan is based on a market rate, like prime, Libor or the 91-day Treasury bill, plus a margin. The margin amount — the number of percentage points you pay over and above the market rate — depends on your creditworthiness. If a lender considers you a higher risk, you’ll pay a higher margin and a higher interest rate on your loan. If a lender considers you a lower risk, you’ll pay a lower margin and a lower interest rate on your loan.

Is there an origination fee? Many lenders charge origination fees on private education loans. There is no cap on origination fees, and they vary by lender, so shop carefully. A high origination fee could make a pricey private loan more expensive.

When do I begin paying? Most student loans don’t need to be repaid until after you graduate. But some private loans may ask you to start making payments right away. Can you handle making loan payments while attending classes?

What is the late fee? Many private lenders charge late fees if your payment arrives 10 or 15 days after the due date. The late fees can be as high as $15 or as much as 5% of the payment amount due. (Federal student loan servicers also charge late fees.)

Can I defer or reduce loan payments during tough times? Hardship help varies from lender to lender, so you’ll want to ask before you borrow. Does the lender offer deferment due to economic hardship or unemployment? Does the lender offer forbearance, a temporary postponement in payments? Will you be charged a fee? How long will the forbearance period last?

Will a private loan affect my eligibility for other forms of financial aid? It’s a good idea to have a private loan checked out by a financial aid official at your college or university. The last thing you want is for a private loan to hurt your eligibility for more affordable forms of financial aid.

Weigh your financial options carefully. Federal student loans tend to have more benefits and repayment options than private student loans. If you do want to use a private student loan, be sure to get the facts first, and no matter what kind of student loan you decide to get, only borrow as much as you can expect to afford to repay.

Have questions about student loans? Whether you borrowed from a private lender or the Education Department, our experts can help you make sense of them. Post your questions in the comments, and we’ll do our best to answer.

This article has been updated. It was originally published August 24, 2010.

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Worried

I already have a private student loan that I am drowning in. It is up to 68,000.00. I was ignorant when I went with this company. Now, I can not find anyone to help me with this. Can anyone tell me what I can do? Please help!

My private loans went from $45,000 to 75,000 due to deferment. My mother co-signed and they kept calling her for payment. I have not been able to get a decent job to help pay back my loans, not even a decent job in my field of study. Are there any companies that can help with refinancing a private student loan and to get my mother off the original private loan.

http://blog.credit.com/ Kali Geldis

Hi —

There are many companies that can help you refinance your student loans. Here’s a good piece on how to refinance with some helpful tips to get you started:

We just wrote a story on this topic but unfortunately if you are not employed, you’re not going to be a good candidate for private student loan consolidation. You may want to contact a non-profit organization that also offers student loan counseling. Two that do are Cambridge Credit Counseling and Money Management International. There may be others–just not sure who they are.

As much as I’d like to help it sounds like you need to get a consumer law attorney with experience in student loans involved. The other alternative is to file a complaint with the Consumer Financial Protection Bureau, but my recommendation is talking with an attorney. Among other things, it is very possible the statute of limitations has expired. You can find one via the websites of the National Association of Consumer Advocates or TheStudentLoanLawyer.com